“Told by an Idiot, Full of Sound and Fury, Signifying Nothing”…or Does It?
Strategic Income Outlook
April 2018

Written in 1606, Shakespeare’s words are just as relevant today. Tweets and eye-catching headlines dominate the news cycle and many conversations, but when you parse them for impactful content, you realize it’s mostly just white noise. Heated debates about whether the Federal Reserve (the Fed) will raise the fed funds rate three, four or more times this year, the constant bloviating by politicians, inflation fears, Twitter battles, grandstanding on North Korea, DACA or the belligerent posturing during the NAFTA negotiations have thus far caused mostly ephemeral reactions and carry no lasting economic impact – the final resolutions have generally been tamer than the brash and furious onsets. Despite these distractions, the economy continues to grow, and in general life goes on. Business leaders and many in government around the world get the joke and are acting rationally. Namely, they are controlling what they have the power to oversee and not focusing on what they cannot. Gross Domestic Product (GDP) growth is rising steadily and inflation is brewing but is not yet a danger. Tax cuts are feeding through the economy, and as the Fed hikes are pushing short-term interest rates higher, savers are finally earning a reasonable return on their cash. Investors would do well to ignore the false signals, tune out the noisy distortions of the facts and focus on what really matters.

As we pointed out in our January 2018 Outlook, the Fed is nonplussed about the causes of inflation and how to control it. Nonetheless, they have pumped the economy full of liquidity since the great financial crisis of 2008 in an attempt to prevent a further meltdown and to generate growth above their 2% target. Success is finally at hand, but rather than causing celebration it seems to have only engendered more hand wringing. As we mentioned last quarter, and our colleague, Eddy Vataru, highlighted on Osterweis.com, two statistical indicators the Fed utilizes – the Underlying Inflation Gauge (UIG) and the Fed Dot Plot – are both indicating continued growth. Heightened inflation often follows accelerating growth and since inflation is generally the single largest factor on the Fed’s watch list, given its dual mandate of stable prices and full employment, it bears further examination.

The widely followed Consumer Price Index (CPI) has risen 2.2% over the last twelve months, which is above the Fed’s annual inflation target rate of 2%. The UIG, which has some predictive elements in it, was 3.06% for February, an increase from the upwardly revised 3.01% seen in January. With both measures well above the 2% target, don’t be surprised if the Fed raises its inflation target! We are closely watching several factors that could contribute to a rising level of prices. One is transportation. Company after company has confirmed on year-end earnings calls that the rising cost of shipping goods to market is becoming a problem. Tougher regulations and a demographic shift away from trucking jobs have created a shortage of long-haul truck drivers in the U.S., and this has driven up costs. So far, companies have mostly absorbed this increase, but that can only last for so long. As they look to pass along these costs, their customers will have little recourse but to also pass them on to consumers in the form of higher prices.